Bank of England governor’s move to persuade markets that interest rates will not immediately rise has provoked skepticism. His first 100 days as Bank of England governor have been a noisy medley of speeches, impeccably tailored photo-calls and pzazz…
If Mark Carney was going to live up to his billing as a “rock star central banker” – and his £874,000 a year pay package – he had to arrive in Threadneedle Street on a crashing crescendo. His first 100 days as Bank of England governor have been a noisy medley of speeches, impeccably tailored photo-calls and pzazz.
From the need for more women on banknotes to his love of Everton football club, Carney has had plenty to say on a range of subjects since his appointment on 1 July this year. However, it’s the Bank’s new policy tool of forward guidance that has provoked the most interest, and a good measure of scepticism, among seasoned Bank-watchers.
Honed by Carney in Canada and adopted by the US Federal Reserve and the ECB in different forms, forward guidance is a way of signalling to the public and financial markets how the Bank will respond to shifts in the economy. In this case, the monetary policy committee has pledged to keep interest rates at their record low of 0.5% at least until the unemployment rate falls to 7%.
“Forward guidance is an attempt to persuade the markets that interest rates are not immediately going to go up,” says John Van Reenen, director of the Centre for Economic Performance at the London School of Economics. “It’s one more tool in the toolbox.”
However, as implemented by Carney and his colleagues in the UK, guidance is hedged about with three separate “knockouts” – rates would rise if inflation, financial stability or the public’s inflation expectations got out of control. Moreover, the governor has stressed that the 7% unemployment rate is not a trigger for a rate rise, but a “staging post”, which will not necessarily prompt tighter policy.
During a somewhat fraught hearing with MPs on the cross-party Treasury select committee last month, in which Carney sought to clarify the policy, chairman Andrew Tyrie expostulated that it would be a hard one to explain “down the Dog and Duck”.
Financial markets have also been less than convinced. The yield, or effective interest rate, on British government bonds – partly a measure of investors’ expectations of future interest rates – has risen rather than fallen since the Bank’s announcement. That is partly because the latest data suggests the economic outlook is improving, but rapidly rising bond yields can be worrying because they tend to push up borrowing costs right across the economy. Carney, though, has insisted he is not concerned.
Meanwhile the pound has risen almost 4% against the dollar since Carney took the helm – again signalling markets expect rates to rise sooner than the Bank is indicating. Last week sterling hit a nine-month high, although it came off that peak as investors began to question if the UK’s recovery could continue at its current pace.
“I don’t think in practice forward guidance is very successful,” says Jamie Dannhauser of Lombard Street Research. He believes Carney has failed to convince the City he means business, because he has failed to back up forward guidance with action, such as the promise of a fresh round of quantitative easing – the Bank scheme that has pumped £375bn of freshly minted money into the economy.
“[Forward guidance] doesn’t work if you’re not willing to take on the markets if you don’t get your way,” says Dannhauser.
David Blanchflower, a former member of the MPC, is more blunt: “He looks already, within a hundred days, to have lost control. Bond yields are rising, the pound is rising like mad, and they’ve got no response.”
He argues that the hedged nature of the new policy is likely to reflect “horse-trading” between Carney and his fellow MPC members. Unlike in Canada, where what the central bank governor says goes, decision-making on the MPC is by vote. With a recovery now under way, its various members are known to have differing views on what are the most pressing risks to the economy.
Another former MPC member said: “Had I been on the MPC I would have let him do it [forward guidance], because I don’t think it does any particular harm; but I don’t think it does much good either.”
It’s not just the Bank’s approach to monetary policy that has changed on Carney’s watch. When outgoing deputy governor Paul Tucker, who missed out on the top job, leaves for the US later this month, it will mark the latest in a number of personnel changes that are starting to make Carney’s Bank look quite different from Lord (Mervyn) King’s.
Blue-blooded banker Charlotte Hogg joined as the Bank’s new chief operating officer, a post that didn’t exist under the old regime, on the same day as Carney. Meanwhile Tucker will be replaced by former Treasury and Foreign Office apparatchik Sir Jon Cunliffe. With long-serving deputy governor Charlie Bean due to leave early in 2014, Carney will be given another opportunity to bring in a new broom.
Insiders say the atmosphere in the Bank’s Threadneedle Street headquarters has already changed. Carney is often seen eating lunch in the canteen or showing visitors around. His approach is less hierarchical than that of King, who was derided as the “Sun King”, by former chancellor Alistair Darling – though Carney is said to be no keener on intellectual dissent than his predecessor.
He will need all the allies he can get both inside and outside the Bank, if he is to deal successfully with what many analysts see as the greatest threat facing the economy: the risk that an unsustainable bubble is starting to inflate in Britain’s boom-bust housing market.
Carney and his colleagues on the Bank’s Financial Policy Committee (FPC), the group tasked with preventing future crashes which partly overlaps with the MPC, have new powers to rein in mortgage lending if they believe a bubble is emerging, and the governor has said he won’t hesitate to use them.
But the FPC is untested and largely unknown to the public, and bubbles are notoriously hard to spot. Using the FPC’s influence to choke off the supply of high loan-to-value mortgages, for example, would be hugely controversial at a time when large numbers of would-be buyers have been frozen out of the market. Meanwhile, the government’s extension of the Help to Buy scheme, with details to be laid out on Tuesday, is likely to increase the demand for property, potentially pushing up prices.
Van Reenen warns that if property prices do take off, Carney could find himself in an unenviable position. “We have this terrible problem in this country that house prices have got completely out of kilter with incomes. I would be very reluctant to see interest rates start pushing up. Using other methods, such as being tougher on Help to Buy, and trying to do things through prudential regulation is better – but the fundamental thing is lack of houses, and Carney can’t do anything about that.”
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Why Australia should fear a US government default
By: All Things Forex
Published October 7, 2013, in Forex Outlook
In May, the US treasury was able to employ some “extraordinary measures” to keep borrowing. These measures run out on 17 October. If the USS America goes down, little HMAS Australia will find it tough not to get sucked into the vortex…
The current US government shutdown has little impact on Australia, but if the US hits the debt ceiling Australia will feel the consequences of a bitterly partisan US political system.
One of the more ironic aspects of the US government shutdown is that if it goes on for much longer, the government won’t be able to calculate its economic impact because it won’t be able to collect the data.
Last Friday was supposed to be the most recent release of US jobs figures, and yet those logging on to the BLS website would have seen this:
During the shutdown the BLS won’t be able to collect the data to calculate the employment figures. Similarly the Bureau of Economic Analysis is also shut down, which rather makes collating data for the GDP figures a tad tricky.
But for Australians the big issue is not so much the shutdown. Costly as it is to the American economy – wiping about 0.1% of GDP growth each week – it does not have a great direct impact outside its borders. After all there are not many Australians employed by the US government or about to go to a US national park this weekend. The real bitter pill for the rest of the world (and US) comes in a couple weeks when the US reaches its debt ceiling.
The debt ceiling is often lazily referred to as the US government’s credit card limit, but it is not about giving the US government the right to spend more, but the ability to borrow to pay off spending it has already undertaken.
The debt ceiling is currently at $US16.699tn, and was actually reached in May but the US treasury was able to employ some “extraordinary measures” to keep borrowing. These measures will run out on 17 October.
At that point the US will no longer be able to borrow money to pay its bills. In the short run that is OK, because the US government gets enough cash from tax revenue to cover its expenses. But on 1 November it gets a bill for US$67bn for social security, medicare and veterans benefits. By 15 November the US government will be short about US$108bn. And that means defaulting on its payments.
No one really knows what will happen if the debt ceiling is not raised. Views range from, it’ll be fine, to it’ll be Armageddon. The US Treasury for its part has put out a paper that paints a pretty scary picture.
After looking at what has occurred in 2011 when the US nearly reached the debt limit, it concluded that a debt default “could have a catastrophic effect on not just financial markets but also on job creation, consumer spending and economic growth”.
It also noted that “many private-sector analysts believing that it would lead to events of the magnitude of late 2008 or worse, and the result then was a recession more severe than any seen since the Great Depression”.
And just in case you are a glass-half-full kind of person and you still have some optimism, the report ends on this less than upbeat note: “Considering the experience of countries around that world that have defaulted on their debt… [the] consequences, including high interest rates, reduced investment, higher debt payments, and slow economic growth, could last for more than a generation.”
Cheery.
Thus far the markets have been rather sanguine. The US Treasury 10-year bond yields are lower now than they were a month ago – suggesting investors are not too spooked about the long-term US economy. There is also a sense that investors are a bit jaded – the debt ceiling fight is now becoming an annual event.
But in the past few days, investors have become very worried about holding US treasury bonds which mature in the next month.
The spread of the six-month to one-month treasury bonds fell off a cliff, to the point where investors are now demanding a higher return for buying a one-month US treasury bond than for a six-month.
Should the default actually occur you could expect those jaded investors would suddenly get very alert. A US government default would put the world economy into uncharted waters. Around 87 % of all foreign exchange transactions involve US dollars. If the US government can no longer guarantee it will pay its bills (even for a short time), that rather upsets the integrity of the entire system.
In 2011 when the debt ceiling was almost breached, the US’s credit rating was downgraded to AA. It hurt US confidence, put a big hand brake on economic growth, and the turmoil on financial markets reduced American household wealth by around US$2.4tn.
For Australia, in 2011 our dollar at the time soared to US$1.10 as the American currency lost value. With the value of our dollar already rising the last thing our manufacturing sector needs is for the dollar to be given a boost.
For the moment most expect congress to back down and raise the debt ceiling (or perhaps even suspend it for a few more months like they did last year).
But Australians should hope that the US gets its act in order soon. While it is nice to think that we are now bound to China, a look over the past 20 years shows that aside from extraordinary circumstances – such as the dotcom bubble and September 11 attack, and our mining boom in 2006 – Australia and the US’s GDP growth is quite closely linked.
Our economy is like a dinghy in the ocean of the international economy. If the US scuttles itself though political intransigence, without another mining boom, little HMAS Australia would find it tough not to get sucked into the vortex as USS America goes down.
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